Why the retail industry is facing a wave of bankruptcies

Revlon makeup products are displayed at a CVS store on August 9, 2018 in Sausalito, California.

Justin Sullivan | Getty Images

The retail sector faces a potential wave of bankruptcies following a months-long slowdown in restructuring activity.

There could be an increase in struggling retailers from later this year, experts say, as rising prices affect demand for certain products, stores face bloated inventory levels and a possible recession looms.

Last week, cosmetics giant Revlon, 90, filed for Chapter 11 bankruptcy protection, becoming the first domestic consumer-facing name to do so in months.

Now the questions are: Which retailer will be next? And how long?

“Retail is in flux,” said Perry Mandarino, co-head of investment banking and head of corporate restructuring at B. Riley Securities. “And in the next five years, the landscape will be very different from what it is today.”

The industry experienced a dramatic pullback in restructurings in 2021 and early 2022 as companies — including those on so-called bankruptcy watch lists — received relief from fiscal stimulus that offered business cash injections and stimulus dollars. to consumers. The break came after a flurry of angst in 2020, near the start of the pandemic, when dozens of retailers, including JC Penney, Brooks Brothers, J. Crew and Neiman Marcus, went to bankruptcy court.

Including the Revlon filing, there have only been four retail bankruptcies so far this year, according to S&P Global Market Intelligence. That’s the lowest number the company has tracked in at least 12 years.

It’s not exactly clear when that count might start to rise, but restructuring experts say they are bracing for more industry-wide trouble as the all-important holiday season approaches.

An analysis by Fitch Ratings shows that consumer and retail companies most at risk of default include mattress maker Serta Simmons, cosmetics line Anastasia Beverly Hills, skin care marketing firm Rodan & Fields, owner of Billabong Boardriders, menswear chain Men’s Wearhouse, supplement marketing company Isagenix International and sportswear maker Outerstuff.

“We potentially have a perfect storm brewing,” said Sally Henry, a professor of law at Texas Tech Law School and a former partner at Skadden, Arps, Slate, Meagher & Flom LLP. “I wouldn’t be surprised to see an increase in retail bankruptcies.”

Still, consultants who have worked on retail bankruptcies in recent years mostly believe that any impending woes in the industry should not be as intense as the big shake-up in 2020. Instead, bankruptcies could be more widespread, they said. they. .

“What you saw in 2020 was a huge amount of restructuring activity being driven,” said Spencer Ware, managing director and retail practice leader at Riveron, a consulting firm. “So we went from 2020 to today with a tremendous amount of stimulus. What’s going to happen now? It’s a little confusing.”

A split in consumer behavior can make things more unpredictable. Lower-income Americans have been particularly hard-pressed by inflation, while wealthier consumers continue to splurge on luxury goods.

“We’re at a point where we’re anticipating that what’s going to happen next is much more complicated,” said Steve Zelin, partner and global head of the restructuring and special situations group at PJT Partners. “There are a lot more variables.”

The clearance shelf at TJ Maxx clothing store in Annapolis, Maryland on May 16, 2022 as Americans brace for the summer sticker shock as inflation continues to rise.

Jim Watson | AFP | Getty Images

The latest retail sales data shows where consumers are retreating the most. Advance spending on retail and food services fell 0.3% in May from a month earlier, the Commerce Department said last week. Furniture and home furniture retailers, electronics and appliance stores, and health and personal care chains all saw month-on-month declines.

“Consumers aren’t just buying less, they’re buying less, which means a loss of the impulse-buying moments that are critical to retail growth,” said Marshal Cohen, chief retail advisor at NPD Group. , a market research firm.

In the first three months of 2022, consumers purchased 6% fewer items at retail than in the first quarter of 2021, the NPD Group said in a survey released in late May. More than 8 in 10 US consumers said they plan to make more changes to reduce their spending in the next three to six months, he said.

A race to stay ahead of rising rates

The threat of future rate hikes — after the Federal Reserve raised benchmark interest rates last week by three-quarters of a percentage point in their most aggressive rise since 1994 — has prompted retailers to turn to debt markets to accelerate those plans. .

Riveron’s Ware said companies are racing to get ahead of future rate hikes. Some have bought back debt or tried to delay maturities. For example, department store chain Macy’s said in March that it had completed the refinancing of $850 million in bonds that would mature within the next two years.

More recently, however, Ware said he has noticed that refinancing activity over the past 12 months has started to slow down, with a greater number of deals being canceled or cancelled. “It looks like the window is closing for more difficult refinancing,” Ware said.

In late 2020, Revlon narrowly escaped bankruptcy by persuading bondholders to extend their maturing debt. But just under two years later, the company succumbed to a heavy load of debt and supply chain problems that prevented it from fulfilling all of its orders.

As has always been the case, retailers dealing with the heaviest debt will be the most vulnerable to bankruptcy, said David Berliner, head of BDO’s business restructuring and turnaround practice.

More angst could start to creep in after the upcoming back-to-school shopping season, he added, after families return from their long-awaited summer break and may be forced to tighten their belts.

A UBS survey earlier this month found that only about 39% of U.S. consumers said they plan to spend more money in the back-to-school season this year than the year before, down from the number of people who said the same in 2021. .

“Consumers are getting more stingy with their wallets,” said Berliner. “There will be winners and losers, as we always see. I’m just not sure when that will happen.”

Berliner said he has been closely monitoring consumer debt levels, which are close to all-time highs.

“Consumers are willing to spend on credit cards, on mortgages and on buy-now-pay-later programs,” he said. “I’m afraid many consumers are using their credit cards and will be forced to abruptly back off.”

If consumer spending were to decline in this way, more retailers could be bankrupted at a faster rate, Berliner said. But if spending remains at a reasonable pace and consumers can reasonably pay their debts, companies will “share some of the pain” with fewer bankruptcy filings, he said.

Either way, Berliner said the angst will be greatest among small retail businesses, particularly retail stores, which don’t have as many resources to weather tough times.

Inventory levels under observation

Rising inventory levels are also on the radar of bankruptcy advisors because they have the potential to lead to much bigger problems. Retailers such as Gap, Abercrombie & Fitch and Kohl’s have said in recent weeks that they have a lot after shipments arrived late and consumers abruptly changed what they were buying.

Target said earlier this month that it is planning markdowns and canceling some orders to try to get rid of unwanted merchandise. As other retailers follow suit, profits will fall in the short term, said Joseph Malfitano, founder of turnaround and restructuring firm Malfitano Partners.

And when a retailer’s profit margins shrink as its inventories are revalued — a routine practice in the industry — those inventories won’t be worth as much, Malfitano explained. A company’s borrowing base could drop as a result, he said.

“Some retailers were able to cancel orders so they don’t create another bubble in stock. But many retailers can’t cancel those orders,” Malfitano said. “So if retailers who can’t cancel orders don’t take it out of the park during the holiday season, their margins will drop.”

“You will have more problems in 2023,” he added.

Shoppers are seen inside a shopping mall in Bethesda, Maryland, on February 17, 2022.

Mandel Ngan | AFP | Getty Images

Ian Fredericks, president of Hilco Global’s retail group, agreed that retail bankruptcies are unlikely to increase until 2023.

“Retailers are not in danger because they are still sitting in a boat full of liquidity … between some cash left on their balance sheet and an undrawn revolver,” he said. “There’s still a lot of clue.”

This just means that the upcoming holiday season, which every year is a vital period on the retail calendar for companies to balance profits, could be even more of a watershed moment for businesses.

“I don’t see a big holiday spending season. I think people are really going to tighten and tighten their belts,” Fredericks said. “Inflation is not going anywhere.”

A further result of an economic slowdown could be an increase in M&A activity across the retail sector, according to Mandarino of B. Riley Securities.

Larger retailers who are more financially stable may want to gobble up smaller brands, particularly when they can do so at a discount. They would use this strategy in difficult times to keep revenues growing quarter after quarter, albeit inorganically, said Mandarino.

Household items, apparel and department stores could face the most pressure in the coming months, he added.

With Bed Bath & Beyond’s eponymous banner underperforming in recent quarters, the retailer has faced pressure from an activist to get rid of its Buybuy Baby chain, which is seen as a stronger part of the business. Kohl’s, an off-mall department store retailer, has also been pressured by activists to consider a sale and is now in exclusive negotiations with the Franchise Group, owner of Vitamin Shoppe. Franchise Group is considering whether to reduce its bid for Kohl’s, a source told CNBC on Wednesday.

“It’s a buyers’ market,” said Mandarino. “Growth won’t come organically when consumer spending drops and if we go into recession.”

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